Borrowers find cheap debt on good terms as lenders regain appetite, reports Paul Yandall
It was London’s hottest day so far this year on the eve of the Commercial Real Estate Finance Council Europe’s Spring Conference last month, so naturally, the question on everyone’s lips was how long will it last? For the weather, not long at all, with the mercury soon dropping rapidly, but London’s property finance professionals are hoping for better.
More than 230 converged on K&L Gates’ St Paul’s offices for the two-day event, to discuss the state of the market and the threats to its relatively benign climate.
Overall sentiment was positive, with more than 84% believing the market was still moving towards a peak and only 4% believing the top had been reached.
Borrowers felt that things had clearly turned in their favour. Funding was becoming cheaper, with competition fierce among lenders. Banks had recovered their real estate appetite, with insurers and debt funds joining the party.
James Clifton-Brown, chief investment officer for CBRE Global Investors, said: “Maximum loan sizes have been increasing in most countries, as have maximum loan-to-value levels; margins have been coming down and I really don’t see that abating, at least in the short term.
“Three years ago in Europe, when we wanted to borrow to buy investments, we practically had to beg. Now, even before we announce a deal, we get phoned by banks wanting to lend to us, before asking them.”
With margins falling and a choice of lenders, one talking point was the value of long-standing bank relationships in today’s market. When put to a vote, around two-thirds of delegates said they’d pay up to 30bps extra margin to a lender they knew and could trust to deliver. Another 18% said a good relationship was worth 30-60bps, and 12% more than 60bps.
But even the strongest of relationships can be called into question in today’s market. “We would have deemed GE Capital to be a relationship lender until a week ago,” said panellist Morgan Garfield of Ellandi.
Although lending is easier, competition for assets is fierce, with reallocations to real estate and new entrants stoking the market. Lending on “shiny” buildings was getting difficult given low yields, a banker acknowledged, but “sensible” margins were still achieveable on transitional property.
Panellists noted that student housing, previously considered an “alternative asset”, has come of age, with institutional money, both equity and debt, entering the sector. One fan of alternatives said the key issue was: “Does the real estate have a bed in it?
“Offices get obsolete very quickly. Most of us work in a 20-year-old building; I live in a 200-year-old house. Alternatives have an underlying strength and value because you can go to sleep in them.”
Clifton-Brown said the wider UK economic upturn was helping to drive occupancy rates. CBRE Global Investors has 35 institutional clients in the UK, with portfolios worth £8.5bn, and he noted the vacancy rate falling rapidly from mid-2013. “In some cases it’s as low as I’ve ever seen it in my career and we could see similar falls in Europe – in fact that’s already begun.”
Despite the general optimism, Stephen Eighteen, head of origination at Aalto Invest, sounded a note of caution: “One of the lessons of previous downturns is that whenever you think things are great, that’s the time to start getting worried. I think we are probably in that situation today.”
Next crash years away
The view of 81% of delegates was that the next property crash would occur between 2016-2020, although there were mixed views on the likely catalyst. A Eurozone crisis was seen as the single most likely cause, cited by 28%; a US Federal Reserve interest rate rise was next, at 21%; followed by falling rents/reduced demand, at 21%.
No matter what the cause, many remained confident of real estate’s long-term prospects, as well as London’s ability to remain at the heart of it.
In his keynote speech, economist Dr Savvas Savouri from Toscafund predicted the rise of the Chinese renminbi would have a dramatic effect on the City, and by association the commercial property sector.
“China as a state is completely ungeared internationally,” said Savouri. “At some point it will stop growing through its current account – making things, importing raw materials, adding value to export – and realise that the way that most economies go through a growth spurt is by issuing debt.
“That will be transformational. It will require its currency to become more freely traded. Not unrelated to this, it will spawn dozens and dozens of derivatives that have to be traded and yes, they’ll be traded in Singapore, Hong Kong and Shanghai, but those centres in the East need to have a Western hub to provide 24-hour trading, and that Western hub will be London.”
Election result looks uncertain for property
For some delegates the looming UK election cast a shadow over the sector. Keynote speaker Gerard Lyons, chief economic advisor to the Mayor of London, said the most likely result was a minority coalition government.
“Two thirds of people now vote in the UK, which is low by historical trends, and only two out of three vote for one of the two main parties. As a result we have a very fragmented and regional system here.
“The result is an uncertain outcome and a minority government, which may reinforce downward pressure on sterling and on the Bank of England to still act as the shock absorber and keep interest rates low.”
Asked “What will happen to London if the UK leaves the EU?” Lyons said it would depend on how the UK acted, in or out.
“The best category for the UK was to be in a reformed EU. But also relatively good, if the UK decides to leave, there would be an initial big ‘V’, where the UK was hit. But if we pursue the right policies and with relatively good terms with the EU, then over a couple of economic cycles the UK does very well.”
Non-bank lenders win vote of confidence
With non-bank lenders’ share of new origination running at around 20% of the commercial real estate debt market, CREFC Europe delegates were bullish about the potential for them to increase their take.
No less than 60% of the audience said they expected this group’s market share to be at least 30% in five years’ time. Some 46% said alternative lenders’ share would be 30-50% of the market and 14% even expected the proportion to climb above 50%.
One category of non-bank lenders, insurance companies, have a big advantage when it comes to winning business, in their ability to offer keen pricing — delegates ranked them second in a question about which kind of senior lenders offer the cheapest money in the UK.
German pfandbrief lenders were the obvious top pick, with 31% of delegates voting them the cheapest.
However, the area where non-bank lenders are most clearly pressing an advantage was on flexibility of loan terms. Two thirds of voters said alternative lenders were able to provide the most flexible terms for loan-to-value ratios, maturities and other covenant structures.
By contrast, German pfandbrief lenders, sometimes accused of being ‘tick-box’ lenders, were seen as being the least flexible.